An important factor in this mild slump has been the strong U.S. dollar. But as I’ll explain, understanding the strong dollar’s impact on the economy and on corporate earnings can help us uncover promising investments in 2016.
First, some background. After three decades of decline, the dollar has rocketed upward since mid-2014; it now sits at a 13-year high against a basket of foreign currencies. Reasons for this include the relatively robust U.S. economy and the official lift off of interest rates by the Federal Reserve on 12-16-15.
The strong dollar has hindered U.S. businesses that sell goods abroad: Revenues generated in foreign currencies effectively shrink when they are converted back into dollars. This dynamic can drive earnings down even when a company’s sales are growing.
Looking ahead to 2016, we don’t expect the dollar to continue its rapid appreciation. We do, however, expect it to remain strong going forward. We also anticipate that price-to-earnings ratios will shrink a bit as interest rates cycle up. Oil, which has fallen sharply this year, will likely find a bottom, providing stability for consumers and businesses alike. And market volatility will continue as short-term investors jockey with each other.
Broadly speaking, we expect another year of muted returns, with U.S. equities rising by low - to mid single digits. How to uncover the most promising stocks against this subdued backdrop? One way is to identify companies whose strengths have been masked by the strong dollar.
For disciplined investors, these under-the-radar opportunities abound. Many large U.S. firms have actually experienced handsomely rising sales amid growing consumer demand globally. The market, with its focus on earnings, has overlooked this story, but we believe that’s a mistake.
Eventually, foreign currencies will head back toward equilibrium with the dollar. As they do, companies with strong sales will begin to grow revenues and earnings. Consider that in a more normal currency environment, U.S. companies would be thriving. By some estimates, the strong dollar has trimmed GDP growth by 1%. With more historically typical exchange rates, we’d be seeing GDP growth of 3% to 3.5%. That level of growth has historically sparked a virtuous cycle, helping corporate earnings grow, and then grow some more.
Right now, companies with otherwise strong sales are being ignored by the market based on the dollar’s drag on their earnings. And that means they’re cheap. At Lighthouse Financial, we believe a portfolio of blue-chip companies with strong management, sales and fundamentals will do well for investors over a one- to three-year time horizon. The key: using a rigorous research process to identify them.
There are always good investment opportunities, even in the midst of market doldrums. Think of them as seeds under the snow. Stake them out, wait for the sun, and they may grow very nicely. Don’t hesitate to contact us if you’d like to learn more.
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